A rosy scenario for stock market, but will it last?

Investors watch job numbers and the Fed after pushing Dow to record high this week.

By Mark Trumbull | Staff writer of The Christian Science Monitor

from the October 5, 2007 edition

Page 1 of 2

America's stock market has been buoyant, even though credit markets are still creaky and an outright recession grips the housing market, a sector that often gives early warning of wider economic slumps.

What has fueled a run-up of stock prices that set a new record high for one key index this week?

The answer, to borrow a phrase from the cold war, may be "containment."

Many investors have gauged that the overall economy is mostly insulated from housing and credit troubles – thanks in part to the Federal Reserve's willingness to provide a monetary nudge as needed.

Similarly, investment strategists are confident that even if the US hits a slow patch, a strong world economy will bolster earnings for the biggest US companies. The world is more insulated from a slowdown in the US than it used to be.

"We haven't seen the end of the impact of the credit crunch," and the housing downturn "has further to go," says David Kudla, chief executive officer and strategist at Mainstay Capital Management in Grand Blanc, Mich. But "we don't expect that it has the ripple effect ...such that it causes a recession or a significant market decline."

If this benign scenario holds true, the stock market could provide some comfort to Main Street as well as Wall Street. It would imply healthy profits at corporations, which could inspire more job-creating investments. And, while not every homeowner owns stocks, it could also help consumer confidence.

At the very least, a resilient stock market would mean that capital gains on stocks would help offset any continuing drop in home prices on America's collective household balance sheet.

In general, the stock market can be a leading indicator of where the economy is headed – since investors are pricing shares based on expected future earnings.

This week, the Dow Jones Industrial Average hit a new record high of 14087.55.

Ironically, the rally came on bad news. Citigroup said its third-quarter profits would be sharply lower, due to markdowns related to the recent credit turmoil. But it said it expected conditions to be improving.

Investors took that, and a similar writing off of credit losses at the investment bank UBS, as a sign that the worst for financial firms may be behind them.

"What was encouraging this week was the transparency coming out of a couple of major financial institutions," Mr. Kudla says. Uncertainty had been holding the stock market back.

All uncertainty isn't over. A key hurdle for bull-market spirits comes Friday, when the Labor Department releases employment numbers for September.

Page 1 | 2 | Next Page